What Is A Pass-Through Entity?

As a business owner, it should come as no surprise that you must deal with government-mandated taxes. It makes sense that, if at all possible, you would want to provide your company with the best possible tax treatment. As a result, you may have heard about pass-through entities. If you are not familiar with what a pass-through entity is, this article will give you key information on what you need to know in order for you to understand it better, and how it might benefit your company's tax situation.

What Is a Pass-through Entity?

A pass-through entity is a type of business that is not subject to corporate income tax. Rather, it passes any income to the owners' individual income tax returns and is liable to the owners' individual rates of taxation. To put it simply, only the income of the business owners of a pass-through entity is taxed, not the overall revenue of the business itself.

Here are the available types of pass-through entities to help you get a better understanding.

Sole Proprietorships

A sole proprietorship is a form of business where one person owns an unincorporated business by oneself. A sole proprietorship, also known as a sole trader, only has a single owner who is responsible for paying personal income tax on the company's profits. As a result, a sole proprietorship is a pass-through entity because there is only one owner and the tax is based on the owner's income, which also means the overall income of the business. Examples of a sole proprietorship are personal or small businesses that are named under the owner’s name, as it's not essential to register a distinct brand or business name as a sole trader.

Partnership Business Entity

A partnership is a legally binding agreement between two or more people to own, manage, run, and divide profits from a business in line with the terms of a written or verbal partnership agreement. It’s possible for each person or each owner in a partnership business may have different shares and different income from the revenue of the business. A partnership business entity is a type of pass-through entity since only the income of each partner will be subject to tax, not the total income of the company.

Limited Liability Companies (LLCs)

LLCs are businesses that protect their owners from personal responsibility for its debts or liabilities, and are owned and operated by several members, however, can also have single ownership. Members of an LLC can be persons, businesses, other LLCs, and international entities. Similar to a Partnership Business Entity, an LLC is a pass-through entity because each of the company's members is subject to taxation, not the LLC's overall income.

S Corporations

S Corporations are types of businesses that are owned and managed by shareholders. S Corporations can choose, for federal tax purposes, to pass through to their shareholder's corporate profits, losses, deductions, and credits. The flow-through of profits and losses to S corporation shareholders is reported on their individual tax returns, and they are subject to the same tax rates as individuals.

How Do Pass-through Entities Work?

A pass-through entity is a great business structure to utilize income tax conditions. A pass-through entity works by subjecting the business owner or owners' individual income to taxation rather than the business as a whole. Instead of being applied to the whole revenue of the company, the taxation mandated by law "passes through" to the owners or shareholders. Following that, the business's owners or shareholders disclose that income on their personal income tax forms.

Advantages of Pass-through Entities

Pass-through entities are typically used by business owners to reduce their tax burden and prevent double taxation on their company's assets, income, and transactions. Pass-through entities, however, have a number of advantages.

Easier to Set Up and Manage

Compared to a typical business, pass-through businesses are generally easier to establish and manage. This is due to the fact that pass-through entities operate under fewer rules and regulations, and the taxing process is more similar to creating and maintaining an individual tax account.

No Restriction on Business Size

A pass-through entity can range in size from a small company with a single owner to a large company with many owners and shareholders. There is no cap on the size of an enterprise and the owner or owners are the ones that are subjected to taxation rather than the total revenue of the company regardless of the size of the business.

Advantageous Tax Rates

The earnings of a pass-through entity are only taxed once, at a lower rate than that of other regular businesses since their owners, or shareholders, are not taxed separately from the entity, as is the case with C corporations. In other words, there is no double taxation for pass-through entities. Instead, the company's income and outgoings pass through to the tax return of the business owner, who then taxes earnings or writes off losses with other personal income and outgoings.

Taxation Flexibility

Flexibility is another advantage of choosing a pass-through tax structure. You’ll have the capability to switch to a different business structure if you've surpassed the tax benefits of your existing one. For instance, partnerships and sole proprietorships can submit papers to the state to convert to an LLC. An LLC has the option to be taxed as a C corporation or as an S corporation. In other words, depending on your demands and the state of the business, you have the ability to adjust how you are taxed.

Conclusion

There is no questioning that taxes are an unavoidable source of state revenue that must be raised by the government and put to good use. Yet, there is also no denying that taxes can occasionally be excessive and have a negative impact on the assets and revenue of businesses. However, the choice of business entity adopted by a business owner can significantly affect how a business files tax returns and pays taxes in ways that may be advantageous to both the business and the owner.

A pass-through entity can definitely assist you in reducing your tax burden on your business's income. You can take advantage of a lot of benefits from pass-through entities if you have a sound plan in place and are well-informed about all the aspects that can lower your tax liability. Core Group is a top-ranked supplier of financial services and tax planning strategies that can give you the assistance you need to benefit from all available tax planning opportunities. We have the resources and expertise necessary to put you in a tax situation that is advantageous to both you and your company.

Contact us today and learn more about how our services can meet your tax needs and assist you in taking your business's financial performance to the next level.